T.C. Memo. 1997-493
UNITED STATES TAX COURT
GARY B. AND KATHLEEN MITCHELL, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 20851-95. Filed November 3, 1997.
Douglas Scott Maynard and Basis J. Boutris, for
petitioners.
Michael F. Steiner and Dale A. Zusi, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
GERBER, Judge: Respondent determined income tax
deficiencies for petitioners' 1987 and 1988 taxable years in the
amounts of $24,716 and $91,878, respectively. Respondent also
determined additions to tax for negligence in the amounts of
$1,236 for 1987 and $4,594 for 1988. After considering
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agreements and concessions by the parties, the remaining issues
are: (1) Whether petitioners are entitled to roll over the gain
on the sale of their residence under section 1034,1 (2) if
entitled to roll over the gain whether any of the improvements
made to the new principal residence qualify for the rollover, and
(3) whether petitioners are liable for additions to tax for
negligence for the 1987 and/or the 1988 taxable year(s).
FINDINGS OF FACT2
Petitioners, at the time their petition was filed, resided
in San Jose, California. Petitioners' 1988 residence (Freemont
property) had not been listed for sale when they were approached
by a real estate broker who presented an attractive offer that
petitioners accepted. The sale occurred on June 21, 1988. The
gain realized on the sale of the Freemont property was $238,380.
The sale occurred quickly and petitioners, who were required to
vacate, purchased as a transitional measure the model townhouse
in a new development while they searched for a permanent
replacement residence. Petitioners were aware that to obtain the
rollover of any gain from the sale of the Freemont property under
section 1034 they would have to obtain and use replacement
1
All section references are to the Internal Revenue Code in
effect for the years in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure, unless otherwise
indicated.
2
The parties’ stipulation of facts and attached exhibits
are incorporated by this reference.
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property as their principal residence by June 21, 1990. About 15
months after the sale of the Freemont property, petitioners
located and purchased for $314,000 a permanent replacement
residence (Fairway residence). The Fairway residence was an
older residence that petitioners intended to improve and
modernize. The interior of the Fairway residence was functional
and completely inhabitable from the date of petitioners'
purchase. The carport, outside condition, and shrubbery were in
a state of disrepair. At the time of purchase, petitioners did
not move into the Fairway residence. Instead they began some
improvements, including tree removal and limited internal
renovations. They also hired an architect and made plans for
improvements. The planned improvements, however, were changed at
least once prior to the commencement of substantial internal
renovations of the Fairway residence. The architectural plans
that were used for the renovations were dated June 5, 1990.
Petitioners' adult son, Matthew, was transferred to a job
location about 125 miles from his and petitioners' home city.
Matthew sold his home located in the same city as petitioners'
residences, and while he was in transition between jobs and in
the process of establishing his new residence at the new job
location, petitioners allowed Matthew to use the Fairway
residence. Matthew's use of the house was for several months
during the first half of 1990. About the time of Matthew's use,
petitioners installed telephone and cable television service.
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Matthew used the Fairway residence until late May 1990 when he
moved to the townhouse and used it until he purchased a new home
during July 1990.
During the spring of 1990 petitioners were packing their
personal belongings, planning their move, and arranging for sale
of their interim residence (townhouse). The townhouse and the
Fairway residence were only a few blocks apart. Throughout the
period concluding on June 21, 1990, petitioners moved items into
the Fairway residence, including lamps, boxes of clothing,
furniture, and household items. The townhouse was placed on the
market without a broker by means of a "For Sale" sign and
petitioner wife personally undertook the effort to sell it. Due
in part to the advice of a real estate developer, petitioners
left some of their furniture in the townhouse and heated and air-
conditioned it during the period it was for sale to improve the
chances of sale.
On June 20, 1990, petitioners, in order to complete the
process of moving into the Fairway residence, hired movers to
handle some heavy items, including a gun safe, large china
closet, large boxes of books, and other heavy items that they
were unable to move themselves. As of June 20, 1990 petitioners
had moved all of their belongings into the Fairway residence,
leaving some of their furniture at the townhouse. On June 20,
1990, the U.S. Postal Service effected petitioners' change of
mailing address from the townhouse to the Fairway residence.
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Petitioners’ neighbor observed their use of the Fairway residence
prior to June 21, 1990, and believed that petitioners resided
there.
As of the 2-year deadline, petitioners had moved all of
their personal belongings into the Fairway property; however, the
major renovations had not been commenced as of the June 21, 1990
deadline. In that connection, a building permit for kitchen and
bathroom additions to the Fairway residence was applied for June
21, 1990, and granted June 27, 1990. Construction of the kitchen
and bathroom additions was accomplished during the period July
through the fall of 1990. A building permit for the garage
addition to the Fairway residence was applied for June 21, 1990,
and granted June 27, 1990. Construction of the garage was begun
during July and completed during the fall of 1990. The county
building inspector, who inspected the construction at the Fairway
residence location, confirmed that no work was commenced on the
garage, kitchen, or bathroom additions prior to the June 27,
1990, granting of the building permits. Various inspections
during September 1990 confirmed that the kitchen and bathroom
additions were not yet complete as of that month. The kitchen
and bathroom additions received their final approval on December
7, 1990. Numerous checks used as payment for the above-described
construction were dated on or prior to June 21, 1990, but not
negotiated and/or cashed or deposited by the payee until after
June 21, 1990, and mostly during July or August 1990. Many of
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the checks to pay the construction company were dated, and cashed
or negotiated during September, October, and November 1990.
The following amounts were paid for improvements to the
Fairway residence that were commenced and completed after June
21, 1990:
Payee Amount
Fontaine Glass $4,858
Moore Painting 4,000
A.B. Plumbing 148
Oswaldo de Santiago 150
R.W. Construction 90,000
Woodburners 2,829
ATNIP Co. 5,793
Budget Electric 4,692
Total 112,470
The person who ultimately purchased the townhouse
(petitioners' interim residence) first viewed the property during
June 1990 and returned about ten times through the time of
purchase during the spring of 1991. The purchaser recalled that
the townhouse contained furnishings but the closets and cabinets
were empty in that the townhouse did not contain clothing, food,
or other personal belongings. The purchaser made the decision to
purchase the townhouse during December 1990 or January 1991.
The utility usage for the period January through October
1990 reflected that the utility consumption at the townhouse
exceeded that of the Fairway residence. During the month of
November the utility use at the Fairway residence increased and
decreased at the townhouse (both precipitously) and for December
1990 use at the Fairway residence exceeded that of the townhouse.
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The utility use at the Fairway residence, even though less in
amount than at the townhouse, tripled in the May - June 1990
period. Likewise, telephone use records for July through
November 1990 reflect that more calls were made from the
townhouse during the predawn and evening hours than at the
Fairway residence. Although a relatively large number of daytime
calls were made from the Fairway residence, many of those calls
concerned the construction and improvements and could have been
made by the construction company.
ULTIMATE FINDINGS OF FACT
Petitioners used the Fairway residence as their principal
residence prior to June 21, 1990. A total of $112,470 for
improvements petitioners claimed to be commenced and/or
completed, were not commenced or completed prior to June 21,
1990, and do not qualify for rollover of gain under section 1034.
Petitioners misrepresented the amount of basis or cost in the new
property and were negligent.
OPINION
The primary issue here is whether petitioners met the
requirements of section 1034. That section permits the rollover
or nonrecognition of gain on the sale of a principal residence if
a new residence "is purchased and used by the taxpayer as his
principal residence", in this case, within 2 years of the sale.
Sec. 1034(a). Petitioners contend that they moved in and
continuously used the Fairway residence as their principal
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residence prior to the June 21, 1990, deadline. Respondent,
relying on utility and telephone usage at the temporary townhouse
and the replacement or principal residence (Fairway), contends
that the record does not support petitioners' contentions and
proffered testimony.
Section 1.1034-1(c)(3)(i), Income Tax Regs., contains the
following standard for use of a principal residence:
Whether or not property is used by the taxpayer as his
residence, and whether or not property is used by the
taxpayer as his principal residence (in the case of a
taxpayer using more than one property as a residence),
depends upon all the facts and circumstances in each
case, including the good faith of the taxpayer. * * *
Section 1.1034-1(d)(1), Income Tax Regs., explains further that
if the taxpayer, during the period within which the
purchase and use of the new residence must be made in
order to have any gain on the sale of the old residence
not recognized under this section, purchases more than
one property which is used by him as his principal
residence * * *, only the last of such properties shall
be considered a new residence * * *
Petitioners bear the burden of showing their entitlement to
the benefits of section 1034 by proving they have satisfied all
of the section's requirements. Thomas v. Commissioner, 92 T.C.
206, 242 (1989) (citing Welch v. Helvering, 290 U.S. 111 (1933)
and Rule 142(a)). In particular, petitioners must show here that
they used the Fairway residence as their principal residence. In
that regard, we said in Stolk v. Commissioner, 40 T.C. 345, 353,
355 (1963), affd. 326 F.2d 760 (2d Cir. 1964):
The elements of residence are the fact of abode and the
intention of remaining, and the concept of residence is
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made up of a combination of acts and intention.
Neither bodily presence alone nor intention alone will
suffice to create a residence. * * *
* * * * * * *
The phrase "used by the taxpayer as his principal
residence" means habitual use of the old residence as
the principal residence. The antithesis is nonuse of
property as the principal residence. [Citations
omitted; fn. ref. omitted; see also Thomas v.
Commissioner, supra.]
Petitioners sought to rollover any gain realized on the sale
of their Freemont property by the purchase of a permanent
replacement residence (Fairway residence) within the 2-year
period. After the unexpected receipt of an offer and the sale of
their Freemont property, petitioners purchased a townhouse as a
temporary or interim residence until a permanent replacement
property could be located. There is no question that the
townhouse then became petitioners’ principal residence which was
used prior to the June 21, 1990, deadline under section 1034.
Just 15 months after the Freemont property sale, however,
petitioners purchased the Fairway residence and moved their
personal belongings, other than some furniture3, into the new
residence prior to the 2-year deadline under section 1034.
Petitioners also planned to make improvements to the Fairway
residence but were not able to begin the vast majority of such
improvements until after the 2-year period ended.
3
Some of petitioners' furniture was left in the townhouse
to enhance its salability rather than leaving that property empty
while petitioners attempted to sell it.
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Petitioners changed their mail delivery from the townhouse
to the Fairway residence, established telephone and other utility
services at the Fairway residence, and their son Matthew lived
there for a period of time prior to the 2-year deadline.
Petitioners, during May 1990, caused Matthew to move out of the
Fairway residence so that they could move in. Matthew had to
store some of his furniture and moved to the townhouse which he
intermittently used until he purchased his own property during
July 1990.
Petitioners intended to and did make Fairway, both legally
and physically, their principal residence prior to the June 21,
1990, deadline. Respondent, however, has shown by competent
evidence that petitioners’ use of the townhouse was substantial
for about 6 months following the deadline. Respondent has shown
that the townhouse utility usage was at least five times larger
than the Fairway residence utility usage during the critical
period just following June 21 through November 1990 when
construction at the Fairway residence was completed. For
example, the July 1990 utility costs for the townhouse and
Fairway residence were $110.95 and $20.90, respectively.
Petitioners counter that the townhouse property was being
intermittently used by Matthew, and that the air-conditioning was
being operated to better facilitate the showing and sale of the
townhouse which had been offered for sale since June.
Petitioners further explained that they were attempting to sell
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the property without a broker and that petitioner wife spent her
days at the property, using the telephone and doing the family's
laundry while she was posted there for the sale of the townhouse.
Petitioners also attempt to explain a pattern of telephone calls
reflecting that the townhouse telephone was used more and at the
crucial times (early and late in the day) when a family member
would normally be home, by explaining that: plans were being
made for Matthew's wedding; Matthew was using the phone early and
late in the day when he stayed in the townhouse; and petitioner
wife would use the phone while she was at the townhouse.
Although petitioners' explanations would account for some of
the inconsistencies between the utility bills and petitioners’
alleged use of Fairway and/or townhouse, the evidence in this
case supports our finding that the townhouse property was being
used to an extent greater than has been explained by petitioners.
Petitioners have shown by a preponderance of the evidence that
they used Fairway as their principal residence prior to June 21,
1990. That evidence includes their testimony and that of their
son, Matthew, a business associate, a neighbor, a construction
workman, and the buyer of the townhouse, all of whom corroborate
petitioners' testimony about their use of the Fairway residence
as their principal residence prior to June 21, 1990. However, a
disparity remains between petitioners' explanation and certain of
the evidence in the case.
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From our perspective, the disparity between respondent's
circumstantial evidence and the petitioners' evidence is due to
petitioners' attempt to show that the improvements to the Fairway
residence were begun and/or completed prior to June 21, 1990.
Petitioners make this argument in order to rollover additional
gain in the amount of $112,4704 in improvements to Fairway. By
contending that they continuously used the Fairway residence from
May 1990 on, petitioners counter one of respondent's arguments
that the Fairway residence was uninhabitable due to the extensive
improvements and disruption to the property. In an attempt to
show that the Fairway residence's improvements were begun prior
to June 21, 1990, petitioners contended that they had moved into
the Fairway residence and stayed there throughout the period
under consideration. This contention is apparently to give the
appearance that the Fairway residence did not need or undergo
extensive renovations after June 21, 1990.
Although petitioners had purchased what they intended to be
the permanent replacement residence (Fairway) 7 months before the
June 21, 1990, deadline under section 1034, the Fairway residence
was older and in need of extensive internal renovations.
Petitioners were at all times acutely aware of the deadline and
attempted to make plans to improve the Fairway residence prior to
4
The $112,470 would represent nearly one-half of a $238,380
gain realized on the Freemont property for which petitioners seek
rollover under sec. 1034.
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moving in. An architect was hired and the plans were made and
revamped; however, the major renovations were not begun or made
before the June 21, 1990, deadline. Confronted with this
situation, petitioners moved into the Fairway residence in late
May 1990 and used the property in a manner and amount that would
satisfy its use as a permanent residence under the statute and
then began the more extensive renovations which created the
inconvenience and/or forced limited use of the Fairway residence.
In that regard, the residence’s master bedroom and bathroom were
under construction. Additionally, a garage was being constructed
adjacent to the residence. These renovations created conditions
which, at very least, made the Fairway residence less than
habitable. At the end of June 1990, after petitioners had used
Fairway as their principal residence, they obtained the building
permits and the extensive renovation was begun. It was after
that time they utilized the townhouse to ameliorate the
inconvenience caused by the extensive renovations. They argued
that their use of Fairway was continuous in order to show that
the renovations were begun before June 21, 1990, and that there
was no change in the residence's condition or their usage.5 The
5
In connection with that argument, petitioners dated
numerous checks (that were eventually used to pay for
renovations) June 21, 1990 (the last day in the 2-year period),
but did not negotiate them and/or the checks were not cashed by
the payees until substantially after June 21, 1990. Most of the
"June 21 checks" were cashed by the construction/payees during
July and August 1990.
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record, however, only supports petitioners' argument that Fairway
was used as their principal residence prior to the critical date,
but the improvements were not begun within that same time frame.
Petitioners' attempt to concoct a scenario to be able to
defer gain based on the renovations caused their testimony, and
that of five people they called as witnesses, to be incongruous
and out of sync with the circumstantial evidence offered by
respondent. Based on the record before us, the only logical
explanation for the incongruity is one where petitioners
established the Fairway residence as their principal residence
and then relied on the townhouse to get them through the heavy
renovation construction that was commenced after the June 21,
1990 deadline.
Respondent cites several cases where the taxpayer only
partially complied with the use requirement of section 1034. For
example, in Bayley v. Commissioner, 35 T.C. 288 (1960), moving a
few pieces of furniture was insufficient to satisfy the used as
principal residence requirement. In Henry v. Commissioner, T.C.
Memo. 1982-469, even circumstances beyond the taxpayer's control
that kept them from moving into the new residence did not
mitigate or obviate the use requirement. Here, petitioners used
Fairway as their principal residence and took the necessary legal
and physical steps to make Fairway their permanent residence.
The precarious aspect of petitioners’ situation is their
ownership of two residences, presenting the question as to which
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should be considered the principal one. It was this aspect that
allowed respondent to make a presentation showing the potential
for petitioner's failure to meet the strict requirement of
section 1034. Ultimately, however, petitioners passed the
threshold use test, and then proceeded to renovate necessitating
their use of the townhouse to allay the inconvenience and
difficulties encountered in their renovation. We hold that the
Fairway residence was used as petitioner's principal residence
prior to the 2-year limit on June 21, 1990.
We also note that petitioners, although well aware of the 2-
year limitation and even though they purchased what was to be
their permanent replacement residence 7 months prior to the 2-
year deadline, allowed matters to slip to the point where they
risked losing the benefit of any rollover whatsoever. The timing
in this case placed petitioners in a precarious position where
they attempted to make it appear that renovations were commenced
and/or completed, when they were not. By waiting until the very
end of the 2-year period, petitioners risked losing any section
1034 benefit.
Respondent, in the event that we decide that petitioners met
the threshold test of section 1034 regarding the Fairway
residence, alternatively argues that petitioners are not entitled
to treat $112,470 of the improvements made to the Fairway
residence as part of the cost of that residence for purposes of
section 1034. Section 1.1034-1(b)(7), Income Tax Regs., defines
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the "Cost of purchasing the new residence" as the "total of all
amounts which are attributable to the acquisition, construction,
reconstruction, and improvements constituting capital
expenditures". Unless the reconstruction or improvement to the
new residence is commenced within the replacement period, none of
the cost may be considered part of the "Cost of purchasing the
new residence". See, e.g., sec. 1.1034-1(b)(7), (c)(4)(iii),
Income Tax Regs.
The record is replete with evidence that the improvements
claimed to have been made by petitioners were not begun prior to
June 21, 1990. The dates that checks were negotiated and/or
cashed, the dates of building permits and inspections, and the
testimony of the county building inspector all firmly establish
that the garage, kitchen, and bathroom additions/renovations were
not commenced until after June 21, 1990, and, therefore, that
petitioners’ expenditures for those projects do not enter into
the cost of the new residence eligible for rollover treatment.
We hold that $112,470 of the improvements to the Fairway
residence were commenced after June 21, 1990, and do not qualify
for section 1034 treatment. See Kern v. Granquist, 291 F.2d 29
(9th Cir. 1961).
Finally, we consider whether petitioners are liable for
additions to tax attributable to their negligence for 1987 and
1988. Respondent determined additions to tax for negligence
under section 6653(a)(1)(A) and (B) for 1987 and section
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6653(a)(1) for 1988. For 1987, if any part of the underpayment
is due to negligence, the addition to tax is 5 percent of the
underpayment, plus 50 percent of the interest due on the part of
the underpayment that is due to negligence. In this instance,
respondent determined that the entire underpayment was due to
negligence. For 1988, if any part of the underpayment is due to
negligence, the addition to tax is 5 percent of the underpayment.
Negligence is defined as the lack of due care or failure to
do what a reasonable and ordinarily prudent person would do under
the circumstances. Neely v. Commissioner, 85 T.C. 934, 947
(1985). Petitioners bear the burden of proving that additions to
tax do not apply. Rule 142(a); Luman v. Commissioner, 79 T.C.
846, 860-861 (1982).
Petitioners claimed on their return that substantial amounts
of renovations ($112,470) were part of the cost of the new
residence and thus eligible for section 1034 treatment, knowing
that those renovations had not been begun prior to the 2-year
limit. Compounding their claim, they dated checks to make it
appear that the total amount claimed on their tax return
qualified, knowing that such dates were not correct.
Accordingly, for the 1988 taxable year in which petitioners would
have been required to report any gain which was not rolled over,
they are negligent. In addition, petitioners did not offer any
evidence to show that any portion of any underpayment for 1987
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was not due to negligence.6 Petitioners simply argue that they
are entitled to section 1034 treatment and, accordingly, are not
negligent. That argument only addresses the negligence issue for
1988. Regarding respondent's 1987 negligence determination,
petitioners have failed to carry their burden inasmuch as they
did not present any evidence relevant to that determination.
We hold petitioners liable for additions to tax for
negligence for 1987 and 1988, as determined by respondent, to the
extent of any underpayment decided for those years.
To reflect the foregoing and concessions of the parties,
Decision will be entered
under Rule 155.
6
The 1987 income tax deficiency was based on seven income
adjustments and a self-employment tax adjustment. Of the seven
adjustments, respondent appears to have conceded one and the
parties settled the others.